Legends Of Indexing: Kelly Haughton

Global Index Group founder and CEO Kelly Haughton has 30 years of indexing experience under his belt. In the 1980s, he created the Russell family of indexes, including the Russell 2000 and the Russell style indexes. He was also responsible for managing Russell’s partnership with the Intercontinental Exchange (ICE), which brought ICE into equity futures trading. In 2003, Haughton received the George F. Russell Jr. Achievement Award for Innovation and Entrepreneurial Leadership. In 2009, he was inducted into the Index Business Association Hall of Fame.

You were one of the great indexing pioneers. Do you think you could launch a new indexing business today and still find the same level of success as when you debuted the Russell Indexes in 1984? Yes and no. Could somebody launch an indexing business like Russell’s today? The answer is no. At this point, in terms of benchmarking large portfolios, that space is full. What we accomplished at Russell in taking on an entrenched player, the S&P 500, and having a lot of success in doing so, will probably go down as a singular event.

But in terms of producing new products—such as index-based exchange-traded products (ETPs)—I think that, yes, there’s plenty of room for more entrepreneurship.

What do you see as the biggest change in indexing over the past 30 years? The biggest change in the industry, I think, is its incredible growth. When I first started, indexing was only a small pocket of the general overall investment industry. Now, the London Stock Exchange is buying Russell Investments for its indexing business for $2 billion.

Or consider the Chicago Mercantile Exchange, which felt like it needed to protect its license to trade S&P 500 and Dow futures by essentially buying a position in those index businesses so it can be on both sides of the table. That’s pretty amazing too.

Then you have the International Securities Exchange running an index business itself and working on various ETPs.

Indexing has become big business. Yes. The mere growth of indexing as a business is very striking. And it’s been a nice ride. There have been so many different evolutions of this industry, and it’s fascinating to see how much it has changed.

Do you think ETFs will continue to be a driver for that growth? Will we get to the point where ETFs will replace, or at least overshadow, mutual funds? I think ETPs will continue to grow in market share compared to mutual funds for at least another decade. It’s hard for me to foretell exactly what the nature of that growth will be, but I fully expect it will happen. And yes, probably most of those assets will come out of mutual funds.

How much further do you think indexing as an industry has left to grow? Well, is indexing ever going to be as big as, say, banking? Probably not. But will it ever be competitive with active management? I would argue it already is. Over the last 20 years, indexing has snagged a bigger and bigger market share from active. You could make a pretty good argument that indexing has grown a couple of orders of magnitude, at least over my career. It has become a nontrivial industry.

But there’s a limit to how big indexing’s going to get. I don’t think this industry has another order of magnitude in it. It will not be 10 times its current size 10 years from now.

Speaking of active management, where does it still play a role in investors’ portfolios? A variety of places. Basically, if you’re an investor who’s willing to tread places nobody else is willing to go, then that’s where you frequently can make outsized returns.

For example, I ran across a hedge fund manager whose primary business strategy was to buy up underwater mortgages, restructure them, and sell them for a profit. I can’t dream of an indexing strategy that would cover that!

So to the extent that we have guys trying to run unusual portfolios like that, I think there will always be niches in the marketplace where hard work and whatnot can result in good returns.

It’s interesting to hear you call active management a “niche” now, especially since, 20 years ago, active was the undisputed king. It was essentially the only way to go. When we went to develop the Russell Indexes, our primary driver, initially, was to help our consulting clients better evaluate active money managers and figure out which ones were good and which ones weren’t.

Prior to that, everybody had been comparing all active managers against the S&P 500, no matter what their strategy was. So if you had a time period where small-cap outperformed large-cap, then all the small-cap managers would say, “Hey look, we’re beating the S&P 500!” The impetus for us was to be able to say, “That’s a silly comparison.”